Category THE ECONOMETRICS OF MACROECONOMIC MODELLING

In the course of the 1980s and 1990s the supply-side of macroeconometric models received increased attention, correcting the earlier overemphasis on the demand-side of the economy. Although there are many facets of the supply-side, for example, price-setting, labour demand, and investment in fixed capital and R&D, the main theoretical and methodological developments and controversies have focused on wage – and price-setting.

Arguably, the most important conceptual development in this area has been the Phillips curve—the relationship between the rate of change in money wages and the rate of unemployment (Phillips 1958)—and the ‘natural rate of unemployment’ hypothesis (Phelps 1967 and Friedman 1968)...

Bardsen et al. (1998) present results of aggregate wage and price determination in the United Kingdom, that can be used to illustrate the third identification scheme above. In the quarterly data set for the United Kingdom the wage vari­able wt is average actual earnings. The price variable pt is the retail price index, excluding mortgage interest payments and the Community Charge. In this ana­lysis, mainland productivity at, import prices pit, and the unemployment rate ut are initially treated as endogenous variables in the VAR, and the validity of restrictions of weak exogeneity is tested...

The traditional approach to building large-scale macroeconometric models has been to estimate one equation (or submodel) at a time and collect the results in the simultaneous setting. Most often this has been done without testing for the adequacy of that procedure. The approach could, however, be defended from the estimation point of view. By adopting limited information maximum likelihood (LIML) methods, one could estimate the parameters of one equation, while leaving the parameters of other equations unrestricted: see Anderson and Rubin (1949)[10] and Koopmans and Hood (1953).[11] It has, however, also been argued that the limited information methods were more robust against mis-specified equations elsewhere in the system in cases where one had better theories or more reliable informatio...

As we have seen, there are necessary conditions for correspondence that can be tested from wage equations alone. This is fortunate, since a range of studies estimate wage models of the ICM type. Often the aim of the studies have been to estimate the NAIRU, or at least to isolate its determinants...

As pointed out by Desai (1984), the reversal of dependent and independent variables represents a continuing controversy in the literature on inflation mod­elling. Section 4.1.1 recounts how Lucas’s supply curve turns the causality of the conventional Phillips curve on its head. Moreover, the Lucas critique states that conditional Phillips curve models will experience structural breaks whenever agents change their expectations, for example, following a change in economic policy. In this section, we discuss both inversion and the Lucas critique, with the aim of showing how the direction of the regression and the relevance of the Lucas critique can be tested in practice.

Equation (7.1) is incomplete as a model for inflation, since the status of xt is left unspecified. On the one hand, the use of the term forcing variable, suggests exogeneity, whereas the custom of instrumenting the variable in estimation is germane to endogeneity. In order to make progress, we therefore consider the following completing system of stochastic linear difference equations3

Apt = 6piApt+i + bP2xt + £pt – bpmt+1, (7.2)

xt = bx1Apt-1 + bx2xt—1 + £xt: 0 E |bx2 I ^ E (7.3)

and substitute xt with the right-hand side of equation (7.3). The characteristic polynomial for the system (7.3) and (7.4) is

If neither of the two roots is on the unit circle, unique asymptotically stationary solutions exist...